Got D&O Insurance? Providing Critical Protection for Your Executives

Few risks are as stressful to a board director or corporate officer as a lawsuit alleging wrongful acts in their employment capacities. This explains why Directors and Officers liability insurance (D&O) is critical to absorbing their legal defense costs in civil and criminal trials and regulatory investigations.

Such actions are not for the fainthearted. At the losing end of civil or criminal trial, directors and officers can pay settlements to the full extent of their net personal wealth, be incarcerated and damage reputations beyond repair. No wonder 71 percent of directors and officers at 325 companies in a 2012 survey by Towers Watson expressed “significant concerns” over the scope of their D&O insurance policy coverage.

If such suits were rare, this stress might be overwrought. But, D&O litigation is common and virtually routine in situations where one company acquires another. According to a report by Cornerstone Research and Stanford Law School, nearly every acquisition of a large U.S. public company in 2012 prompted multiple lawsuits once the deals closed. The report cited evidence of 740 lawsuits filed against directors and officers involving M&A transactions—hence the abundant worries.

A particular fear-inducing gulper is the possibility that the financial limits of protection afforded by a company’s D&O insurance might be exhausted in a lengthy and financially punitive trial. Without the employer indemnifying the individual directors and officers for these losses, they would have to personally dig into their wallets to pay legal defense and the settlement.

Fortunately, the insurance industry recognized this threat in creating Side A insurance, a D&O policy feature providing direct coverage to an organization’s directors and officers in situations where the employer is not legally required to indemnify them. “Side A is the most important coverage in a D&O program,” said Dan Bailey, a partner at the Columbus, OH-based law firm Bailey & Cavalieri, which specializes in D&O litigation. “It’s the ultimate backstop, assuming it is crafted correctly to provide the maximum coverage possible.”

More Policy Power

This explains recent enhancements to Side A coverage by two major D&O insurers—ACE and Zurich. Both policies respond to the rise in D&O liability for directors and officers of U.S. multinational companies. While many foreign countries in past were slow to catch onto the D&O bandwagon, this is no longer the case, with several foreign jurisdictions moving ever closer to U.S. litigation and regulatory standards.

“A number of European countries have adopted forms of collective redress somewhat similar to the U.S. class action system that have led to increased shareholder litigation against corporate executives and board members,” according to a 2012 report by Advised. The study cites several high-profile corporate failures linked to the perceived or actual negligence of these organizations’ directors and officers, guiding the European Union and its member states to pass corporate governance reforms resulting in “heightened accountability” for these executives.

“Today, it is the indemnification issue that most concerns directors and officers,” said Lee Lindsay, managing director, international, in insurance broker Aon’s financial services practice. “The problem is the limitations on indemnification that exist outside the U.S.”

These limitations are evident in countries where regulators do not permit corporate indemnification by local insurers, including China, Brazil, Mexico, Japan and India, according to Paul Schiavone, chief underwriting officer, special lines, at Zurich Insurance Group.

“A master global policy in past effectively addressed D&O exposures abroad, but now many countries insist that only local admitted insurance carriers can provide D&O insurance,” Schiavone said. “Many carriers have addressed this problem by having subsidiaries on the ground in these countries to provide the underlying insurance, or developing fronting arrangements with local carriers. The problem is that these carriers, in some countries, are not permitted to indemnify companies or their directors and officers. It’s against regulations.”

The insurer has responded to the coverage gap with ZEUS (Zurich Executive Universal Select) D&O insurance. “This policy enhancement is drafted in local language and filed where necessary to meet all local requirements,” Schiavone said. “If the local D&O policy cannot by law provide indemnification, the tower of insurance provided by our master D&O policy drops in to take care of this exclusion, right down to the first dollar [of loss].”

ACE Bermuda launched a new CODA Premier D&O policy in October for similar reasons. “Due to heightened regulatory actions and enforcement activities overseas, particularly with respect to FCPA (Foreign Corrupt Practices Act), the UK Bribery Act and stricter environmental regulations, the risk of a company becoming bankrupt from an environmental liability situation and its directors and officers being held responsible for remediation costs has greatly enlarged,” said Robert Wolfe, senior vice president at ACE Professional Risk. “Our D&O policy must adapt accordingly.”

The new policy will reinstate the liability limits of financial protection in a D&O policy in situations where these limits are exhausted—at no additional premium expense to the policyholder. “If the policy assets were seized by a foreign government or some other enforcement party, preventing a director or officer from leveraging the Side A limits, the new feature automatically reinstates the limits,” Wolfe said. “This is true `worst case-scenario’ insurance protection.”

Attorney Bailey concurs: “Different insurers continue to come out with new and enhanced Side A policy features, eliminating more and more exclusions, reinstating limits, and addressing the regulatory issues in some foreign countries. Like so many other insurance issues, it is absolutely critical to seek assistance from a truly knowledgeable broker or legal advisor who understands these evolving liabilities and knows the current marketplace,” he said.